Talk is cheap

We don't manufacture anything any more. Most of the world won't buy our records or watch our films. Only our gift of the gab is keeping Britain's economy ticking over. But how long can the hot air last, ask Larry Elliott and Dan Atkinson

We all know what the Germans are good at. They do precision engineering: all those quietly humming washing machines and the cars with their sleek bodywork and gleaming chrome. We also know that Germany is a country in serious trouble, failing as it has to embrace the need for flexibility in the tough new global environment. We know this because Gordon Brown has told us many times over the past 10 years that the European model is washed up.

Germany was so abysmally competitive last year that it ran a record trade surplus and was the biggest exporter of any country in the world.

We know what the Japanese excel at also. In Tokyo and Nagoya there are world-beating companies in the field of electronics, designing the latest consumer gizmos. We know, too, that despite Sony, Panasonic and Mitsubishi, Japan, like Germany, is a country in serious trouble. It, too, has tried to stick its head in the sand and persist with an industrial model that may have worked in the 1960s and 70s but is an anachronism in 2007. Poor, washed-up Japan ran a trade surplus of around £50bn last year as it found a ready market in China for its exports.

And so it goes on. The French have an ultra-competitive manufacturing base that specialises in food and drink; the Scandinavians are a dab hand at mobile phones; the Americans do computers, aircraft and movies; even the poor, benighted Italians have upmarket designer clothes. So what is Britain good at? Where does the UK fit in this world of changing economic geography, in which nations will increasingly concentrate on the things they do best? The answer is simple. We count the money and we do the bullshit.

Britain, on the 10th anniversary of Tony Blair's arrival in Downing Street, is a place whose default mode for earning its crust is to employ the gift of the gab. The Germans may have the engineers, the Japanese may know how to organise a production line, but the Brits have the barristers, the journalists, the management consultants and the men and women who think that making up jingles and slogans in order to flog Pot Noodles and similar products is a serious job. It has the deal-makers in the City who make fat fees by convincing investors to launch bids for companies, and the corporate spin doctors who tell former pals in financial journalism that tycoon X will make a better fist at running Ripoff plc than tycoon Y. It has the publishers and it has the "film development" companies, some of which have actually been known to produce a film. The four iconic jobs in 21st-century Britain, according to a thinktank called the Work Foundation, are not scientists, engineers, teachers and nurses but hairdressers, celebrities, management consultants and managers.

Before he came into politics, Blair was a lawyer, as was his industry secretary Alistair Darling and the transport secretary Douglas Alexander. Brown's sole experience of the go-getting world of the private sector was as a journalist for Scottish Television. Not that the other parties are much different. David Cameron prepared for the task of repositioning the Conservative party by acting as PR for Carlton TV in the 1990s. He was described by one business editor, the Sun's Ian King, as a "poisonous, slippery individual" and a "smarmy bully who regularly threatened journalists who dared to write anything negative about Carlton". When you get down to it, this is a country that tries to make its living from talk, talk and more talk.

But how has Britain fared when it comes to paying our way in the world? Have the traders in the forex markets and the regulars at the Groucho Club earned enough to make the UK's age-old problems with the current account a thing of the past? Sadly not. Britain still has a world-class pharmaceutical industry, and still makes a tidy sum from selling arms abroad, often to some pretty unsavoury regimes. Yet the deficit in visible trade in goods - stuff we make - was more than £60bn in 2006. That's around 5% of GDP, far bigger than anything the UK has witnessed in the postwar period. Trade in services - accountancy, insurance, banking, architecture, advertising - brings the deficit down to around 4% of GDP. But for the past decade, the only thing that has made the deficit manageable is that Britain has been earning more money on its investments abroad than foreign investors have made here. One way of looking at Britain is as one big offshore hedge fund churning speculators' money while asset-strippers draw up plans for the few remaining factories to be turned into industrial theme parks.

That is not the way the government sees it, naturally. Labour believes Britain is at the cutting edge of the knowledge economy and that Britain's well-educated (sic), highly skilled (sic) and entrepreneurial (sic) workers are ready to kick German, American, Japanese and Chinese butt all round the global village.

The essence of successful bullshit is that the really top-notch exponents not only manage to convince others but also manage to delude themselves. Some explanation has to be provided for Britain's increasingly lopsided economy, dominated as it is by those not-so-heavenly twins, the City of London and the housing market. And the explanation is that the UK's future lies not, as might seem apparent at first glance, in the drinking factories, the estate agencies and the clothing chains that make up Britain's monochrome Identikit high streets, but in the knowledge economy.

Even more laughably, some cling to the idea that the way ahead is the even more nebulous "creative economy". This fantasy, a particular favourite, is that while Britain may no longer carry the overt industrial clout it once did in the days when it was the workshop of the world, it can still be the world's creative hub. The country of Shakespeare and Wordsworth, of Chaucer and Larkin, still has a literary tradition of which to be proud. Rock'n'roll is an English-language medium and there are billions to be made by our cutting-edge bands. Britain's television is a cut above the rest, and the only reason the film industry has declined since the days of Passport to Pimlico is a lack of government backing, now happily remedied, for the inspirational new film-makers emerging from university courses.

Well, we did warn you that the bullshit merchants are good at what they do.

We'll return to the creative industries, but you have to admit that Britain as the world's creative hub sounds a lot more impressive than saying that Britain is at the cutting edge of the call-centre economy, even though the number of people answering phones and inputting data into computers in white-collar industrial sheds now stands at just under one million. And it really would not do to say that Britain is a servant economy, even though there are at least four million people "in service" and the proportion of the population employed by the well-off to do their cooking, cleaning, childcare and gardening is as high as it was in the 1860s.

This, in the modern political jargon, is not the right sort of narrative. The idea that millions of people are toiling away in menial, low-paid, low-skill jobs jars with the impression Blair and Brown wish to convey: that Britain is an exemplar of how vigorous and committed western nations can ready themselves to meet the challenge from Asia. This, though, has proved only a minor difficulty. In Bullshit Britain you simply come up with a different kind of reality that provides you with the sort of narrative you prefer.

The story as far as New Labour is concerned is that our failure in the second half of the 20th century to exploit the potential of higher consumer spending on cars, washing machines, hi-fis and personal stereos has actually left us better placed to exploit the sunrise industries of the 21st century - biotechnology, robotics, environmental protection, pharmaceuticals. Successful economies will require brains more than brawn, and Britain is full of smart people.

There is an element of smoke and mirrors in all this, however. It is true that as countries develop, the number of people employed in services tends to go up. The reason for this is that productivity growth in manufacturing is much faster than it is in services: it takes far fewer hours to make a car today than it did 100 years ago, but the same time to cut someone's hair. It is also true that each wave of capitalism since the industrial revolution has been based on a distinctive technology: coal and steam, then railways and electricity, then mass transportation and consumer goods. Although the vast numbers of poor people in India and China (let alone Africa and Latin America) suggest there will still be strong demand for consumer durables and machine tools for a good while yet, information technology and the human genome may be at the centre of the next long upswing.

But how do you square this with what's happening in Britain? It's simple: Britain has a long tradition of excellence in science, especially chemistry, and the government's commitment to the knowledge economy is evident from its target of ensuring that 50% of young people go to university. New Labour, therefore, has a neat syllogism. Britain is turning out more and more graduates. They are entering the workforce with the knowledge they have acquired through the education system. So, work is becoming more knowledge-based.

The problem, though, is that the syllogism is false. Many graduates are doing fairly menial jobs for which they do not need a degree (or anything like it). Research by Essex University's Institute for Social and Economic Research in 2002 found that a third of men and 41% of women were overqualified for the first posts they took up after graduating. As James Heartfield's study Great Expectations: The Creative Industries in the New Economy found, most employment growth has been, and will continue to be, at the low-skill end of the service sector - in shops, bars, hotels, domestic service and in nursing and care homes. The fastest-growing occupation in the UK between 1992 and 1999 was hairdressing.

'Braining up" may not be a bad strategy for the UK, and there are undoubtedly areas of the knowledge economy where Britain excels. But the size and strength of this high-productivity, high-profit sector has been massively exaggerated. A case in point is spending on research and development, something that is seen as a vital ingredient in developing new product lines and is one of the government's economic priorities. Every year the Department of Trade and Industry publishes an R&D scoreboard to show how UK firms compare with the rest of the world. The findings are chastening, with Britain's presence virtually insignificant in seven of the 10 sectors measured. More than half of the UK's effort in R&D is spent in just two sectors, pharmaceuticals and aerospace - two sectors, incidentally, where support from the government via the NHS and the Ministry of Defence has been considerable over many decades.

Analysis by the Guardian showed that one factor in Britain's poor performance was the higher cost of raising funds for investment in the UK, a constant complaint from industry for at least a century and probably longer. In all 10 sectors looked at - automobiles and parts, IT hardware, pharmaceuticals and biotechnology, electronic and electrical, software and computer services, chemicals, aerospace and defence, engineering and machinery, telecommunications, and health - the UK cost of funds was among the highest in the developed world.

A report last year from the National Endowment for Science, Technology and the Arts (Nesta) admitted that, judged by the traditional yardsticks, Britain does poorly. It devotes a smaller proportion of national income to R&D, and that investment tends to be heavily concentrated in just one or two sectors. According to one international study cited by Nesta, only 38% of British enterprises were engaged in "innovation activities" - three percentage points below the EU average and well below Germany (61%), Sweden (47%) and the Netherlands and Finland (45%). The picture was still worse when more radical forms of innovation were considered: only 21% of UK enterprises had introduced new or significantly improved goods or services over the previous three years, compared with an EU average of 31%.

Yet, according to Nesta, Britain still had "one of the strongest economies in Europe". This, said Nesta, was a paradox. If innovation was really so important, how come the UK had been growing robustly? Its answer was simple: the data were misleading. "The resolution of this paradox lies in the way in which innovation has typically been measured." Well, that might be one explanation. Another might be that growth in Britain had been boosted by a substantial expansion of the public sector, with Brown using the budget surpluses built up in the late 1990s to keep the economy afloat during a global downturn. Another might be that a colossal wave of property speculation was allowing consumers to borrow against their main asset and so live beyond their means.

Nesta's list of areas in Britain where innovation was alive and well only heightened the suspicion that it was scratching around for some good news. These included the National Cycle Network, regulations and incentives to improve social housing, networking among NHS scientists that has resulted in new genetic tests, and "aggressive" tax planning. Now, it could be argued that a National Cycle Network is a fine idea, but so was the idea to create the National Parks during the Attlee government. Similarly, NHS scientists have been working to alleviate pain and save lives since 1948. The idea that some of the smartest (and best-paid) people in Britain spend their time dreaming up ways for the super-rich to avoid paying tax would be fine economically, if not perhaps morally, were the proceeds of this innovation sufficient to make up the deficiencies elsewhere.

Still, the fantasy lives on that even if Britain eventually outsources all its manufacturing to cheaper countries abroad it will still be able to do the tough and lucrative bits - the design for new products - at home. In the days of Cool Britannia back in the late 90s, Blair called the UK the "design workshop of the world", while three years later, the Department for Culture, Media and Sport noted that "Britain is a top exporter of design worldwide and many design consultancies earn a significant portion of income from work outside Britain".

Not, however, as much as they did. Overseas earnings from design fell from £1.4bn in 2001/2 to £699m in 2004/5, while the number of people employed in the design workshop of the world fell from 82,000 in 2000/1 to 71,000 four years later.

Optimism, though, is what Bullshit Britain is all about. Some of it, to be fair, is justified. Britain has real and enduring strength in business services: in accountancy, banking and insurance it runs a healthy trade surplus. The City is one of the world's three financial hubs, and perhaps the most vibrant. Some of the claims made for the new knowledge economy are, however, nothing more than hype, and nowhere is this more true than in the case of the creative industries.

The idea that Britain could be the Athens to the rest of the world's Rome, compensating for its dearth of economic and political clout through intellectual and cultural superiority, first became popular around the middle of the last century. In 1996, David Puttnam took up the theme, writing that Britain was no longer the "island of coal surrounded by fish" that Nye Bevan had talked of. More questionable, however, was the second part of Lord Puttnam's analysis - that Britain was now "an island of creativity surrounded by a sea of understanding".

New Labour was only too happy to go along with this notion. Blair made much of the fact that he was a member of the rock'n'roll generation, inviting members of the Britpop aristocracy for champagne receptions and letting it be known he liked to play a few licks on his Fender Stratocaster. As New Labour's veneer of liberalism peeled away, rock stars quickly backed off. They soon worked out that the fact that Blair could play the guitar did not mean he was right on; it simply meant he knew the chords to Stairway to Heaven. Even so, the creative industries still feature heavily in government propaganda.

A large number of people work in the creative industries, broadly defined, although not nearly as many as the hype would suggest. There are three times as many people working in domestic service as there are in advertising, television, video games, film, the music business and design combined; the creative industries represent around one in 20 of the people working in Britain today. Between them they account for around 4% of UK exports of goods and services but, as the Nesta report made clear, it is hard to make serious money: "The UK's creative industries are facing increasing international competition . . . UK television exports have fallen for the second year running (despite an overall increase since 1998). In design, overseas earnings have halved since 2001, while the value of exports in music, the visual and performing arts in 2003 was down 20% from 2000."

The report goes on to note that employment in advertising had fallen by 20,000 in three years, after reaching a high in 2001. Film production spending was nearly a third lower in 2005 than in the previous year. The number of people working in games development had fallen by 6% since 2000.

Despite repeated attempts to use romantic comedies starring Hugh Grant to revive the British film industry, there is not the remotest sign of Hollywood's stranglehold on the UK market being weakened. In 2004, US-financed films accounted for almost three-quarters of UK box office receipts, while the number of UK films in 2005 released stood at 37, well down on the peak of 84 in the late 1990s. "The UK industry is vulnerable in structural terms," Nesta concluded. "It is organised primarily around individual film projects rather than sustainable production and distribution companies, as in the US."

That is, perhaps, one way of looking at it. Another way is to draw the conclusion that Hollywood operates like a proper industry; it makes films it thinks punters will want to watch. The UK industry, as Heartfield noted in 2000, is dominated by dilettantes who make films they think punters ought to want to watch: "Down-at-heel bohemians make films about the working classes. Unsurprisingly, mass audiences find these patronising diatribes uniquely unappealing."

The idea that the same may be true of British television has gradually been percolating in the national consciousness over the past few years. Jimmy McGovern, who created one of the better TV series of the past two decades, Cracker, went on the attack at the 2006 Edinburgh Television festival against "latte-drinking, pesto-eating middle-class" TV executives for their patronising and offensive treatment of Britain's working classes. "I am delighted to see the state ITV are in," he said. "It is simply because they have utter contempt for their audience. These executives don't sit around and say, 'What kind of intelligent, informative, thought-provoking programmes would we like to watch?' They think, 'What will the ignorant plebs that watch our channel want to see?'"

When TV executives are not pushing at the boundaries of trash TV, they are importing programmes from abroad to fill the gaps in the schedules. Although the UK television industry employed more than 111,000 people in 2004 and spent more than £2.6bn on original programmes, it was still not enough to meet demand. In 2005, Britain had a deficit of £332m in TV.

Finally, there is music, a sector that has been a real breadwinner for the UK ever since the Beatles arrived in New York in February 1964. Here, too, the recent signs have not been encouraging. A month after they appeared on the Ed Sullivan Show, the Beatles filled the top five places in the US charts; in 2002, for the first time in the subsequent 38 years, a year went by without one British artist making it into the US top 100. The same trend applied to albums.

So, to sum up, the film industry is in trouble, the television industry is in trouble and the music industry is in trouble. The creative industries, for all the attention lavished on them by New Labour, were actually in a much healthier state when Harold Wilson and James Callaghan were in Downing Street in the 1960s and 70s. One way of looking at the British economy of today is to say that there are clusters of excellence around science, finance and the arts. Another way of looking at the economy is to say that the pharmaceutical industry will eventually migrate to the United States, where the money is; that big finance would come a cropper in the event of a bursting of the debt-driven speculative bubble; and that Bullshit Britain reaches its apotheosis in the lionisation of the cultural industries.

It is conceivable, just, that Bullshit Britain really is the future, but that those of us wedded to traditional measures of success are not sufficiently hip to cotton on to the fact. But consider: China and India are churning out more graduates than the UK; science departments in British universities are being closed down; the British band that attracted the most attention in the United States last year was not the Arctic Monkeys but the Who.

It would be comforting to think that Sir Paul McCartney had passed on responsibility for fixing the hole in the balance of payments to his fashion-designer daughter, Stella. The reality, though, is that the iconic figure in modern Britain is neither Sir Paul nor his daughter, but his second wife, Lady Heather Mills McCartney. She managed to woo one of Britain's richest men into marriage and claimed a share of his £800m fortune when the blissful partnership strangely went sour after four years. And she understood the essence of the bullshit economy: with luck and attitude, you can make a tiny amount of talent go a very long way.

· Extracted from Fantasy Island, by Larry Elliott and Dan Atkinson, published by Constable, £7.99. To order a copy for £7.99 with free UK p&p go to theguardian.com/bookshop or call 0870 836 0875.